The Concept of Global Banking is now Encompassed by Schrödinger's Box.

In the investment world, it's important to have faith in the system. Unfortunately, trust is currently shaky and there could be even more negativity ahead.

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The author is a contributing editor for FT.

The renowned concept of quantum mechanics presents a scenario where a cat is confined in a box with lethal material, and you cannot determine whether it's survived unless you unseal the box. Until then, the cat remains alive and deceased concurrently. Comparably, banking presently operates under uncertainty, as it's complicated to discern whether the recent week's troubles are isolated incidents that won't spiral into another banking crisis resembling the one from 2008. At this point, it's both a separate and potentially widespread event.

Those who invest or deposit their money in banks need to have trust not only in their financial strength, liquidity, and ethical behavior, but also in the regulations and oversight that were created after the financial crisis of 2008 to prevent another collapse. While there may be varying levels of confidence in the short term, ultimately people either have faith in all of these factors or none at all. It's an all-or-nothing situation - like a cat that can't be partly alive and partly dead.

The recent problems in the banking industry seem to be related mostly to issues with management and supervision, and are not likely to spread beyond a few specific banks. Silicon Valley Bank, Silvergate Bank, and Signature Bank were particularly affected by interest rate risk due to their clients' investments in a low-rate environment and their own holdings of long-term bonds, which they had to sell at a loss to cover deposit redemptions. First Republic, which caters to wealthy clients who may not have insurance, is also facing concerns about its ability to handle liquidity. Credit Suisse, a bank that has faced numerous difficulties in the past, is currently struggling with both liquidity and investor confidence.

Great things have occurred since 2008. Banks have become stronger with respect to their capital and regulation compared to the past when the global financial crisis hit. Even though that was a terrible period, we gained knowledge from it, including the necessity of taking quick and resolute measures to prevent the spread of financial disaster.

The playbook for solving a liquidity crisis was quickly retrieved by central banks, who acted as a last resort lender. SVB and Signature Bank had their deposits ensured by the US Federal Reserve, Treasury, and FDIC. Moreover, a new lending program, called the Bank Term Funding Program, was established by the Fed to assist banks who held securities they could not sell. In addition, the Swiss National Bank offered Credit Suisse a credit line that could be as high as SFr50bn ($54bn).

I believe that central banks and regulators need to take stronger actions in order to reassure people that the banking system is trustworthy, as people's faith in it is faltering. I am concerned that there may be further unexpected issues that arise, which could put the entire system in jeopardy. In the United States, small banks have a significant portion of their loans invested in commercial real estate, making up 28% of their total loans, in contrast to only 8% for larger banks. Due to high interest rates and the shift to remote working during the pandemic, some of these loans may no longer be profitable. If even a small number of these banks have to decrease the value of their assets, it could raise concerns about their financial viability and cause panic in the banking industry.

There is another danger in the world of private markets. Unlike public markets, they are not obliged to regularly assess and reveal the true value of their assets. This means that while public markets have had significant losses over the last year, private markets have been able to report minimal losses on paper. However, this does not mean that they have not actually suffered in terms of asset value. Rather, they may be hesitant to admit this and hope that the value of their assets will bounce back. The problem is that if asset values keep sinking, the real losses could be enormous. In such a scenario, the stability of the entire financial system could be at risk due to the behavior of private markets.

We cannot jump to conclusions and worry about the collapse of the banking system, but we may encounter some market disruptions as central banks proceed with rate hikes and decreasing their balance sheets. We have faced similar banking issues twice in the past twenty years, during the financial crisis and eurozone crisis. It is essential for us to work on restoring trust in the system to ensure its stability. Despite the possibility of the situation being better now, we cannot assume that it will always be the case.